One common mistake in business is the tendency to judge decisions by what happens after they are made. Everything is obvious in hindsight, and knowing what happened makes it too easy to go back and confidently separate information from noise. If ImClone's stock had risen after Martha Stewart sold it, we might now consider her Dec. 27 sale premature and/or dismiss Sam Waksal's attempt to sell some of his own shares as immaterial. Because Waksal's attempted sale was followed by bad news and a tanking stock, however, we now regard it as an obvious sell signal. But to evaluate the propriety of Stewart's trade, we have to analyze not what she and the market knew 36 hours later (that the FDA would reject ImClone's cancer drug Erbitux), or several months later (confirmation that Waksal had, in fact, idiotically tried to dump stock before the news was made public), but what they knew at the time of the trade.

The story began in October 2001, when the pharmaceutical company Bristol-Myers Squibb made a tender offer to buy 14.4 million shares of ImClone at $70 per share. Martha Stewart, who had owned ImClone for several years, "tendered" all 5,000 of her shares. As it happened, the tender offer was so oversubscribed that Bristol-Myers could buy only 21 percent of the tendered shares, leaving Stewart with 3,928 shares. Around this time, in a then-unrelated event, ImClone filed an application with the FDA requesting a review of Erbitux, a key new cancer drug. The FDA had 60 days to respond.

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Approximately 50 days later, on Dec. 20or 21, Stewart's financial adviser at Merrill Lynch, Peter Bacanovic, printed a list of the stocks in Stewart's portfolio for a standard year-end review. This list, which provided details about each position, was titled "Unrealized Gain/(Loss) Summary by Security." The markets had been crushed in 2001, for the second straight year, so Stewart, like most investors, had opportunities to engage in "tax-loss selling"—ditching stocks that have lost money to offset gains on those that have made money, thus reducing that year's capital gains tax. On the phone, Stewart and Bacanovic reviewed the portfolio stock by stock, with Bacanovic making notes on the "Unrealized Gain/(Loss)" sheet with a blue ballpoint pen. When they got to the 18th stock on the list, ImClone, then trading in the low $60s, Bacanovic recommended that Stewart sell it. Stewart rejected the suggestion, but contends (as does Bacanovic) that they agreed that, if the stock ever fell to $60, she would sell it then. (The prosecution contends that the "$60 agreement" is a fabrication.) Over the next two days, Bacanovic executed tax-loss selling for Stewart in 22 stocks.

Waksal: Sins of the father?

One week later, on Dec. 27, Peter Bacanovic was on vacation in Miami, and Martha Stewart was flying to Mexico for a vacation. Between 9 and 10 a.m., Bacanovic's assistant at Merrill Lynch, Douglas Faneuil, received a request from the daughter of ImClone's CEO, Sam Waksal, to sell all of the ImClone stock in her account (39,472 shares, which netted approximately $2.5 million). Faneuil also received a written request from Sam Waksal to transfer all of the ImClone stock in his account (79,797 shares worth approximately $4.9 million) to his daughter's account. The request was marked "URGENT—IMMEDIATE ACTION REQUIRED." Faneuil then received a call from Waksal's accountant, who requested that all of the transferred stock be sold. Merrill Lynch, treating the transferred shares as though they were still Sam Waksal's, refused to sell them without permission from ImClone's general counsel.

Around 10 a.m., Faneuil told Bacanovic about Waksal's daughter's sale and Waksal's attempted sale (and, presumably, about other ImClone information, as described below). Shortly thereafter, at 10:04, with ImClone trading at approximately $61.50, Bacanovic and Faneuil called Martha Stewart's office. Bacanovic left a message that Stewart's assistant, Ann Armstrong, recorded as "Peter Bacanovic thinks ImClone is going to start trading downward."

Three hours later, at 1:26 p.m. ET, Stewart's private jet landed in San Antonio, Texas, to refuel. From the tarmac, Stewart made three calls on her cell phone: a one-minute call to her home answering machine (1:30 to 1:31); an 11-minute call to her office (1:31 to 1:41), near the end of which she was transferred to Bacanovic's office; and a two-minute call to ImClone's offices (1:41 to 1:43). During the call to her office, Stewart discussed business matters and phone messages with Armstrong. That day's messages included not only Bacanovic's, but a note of thanks for a plum pudding ("excellent"), an inquiry as to whether someone "could be on your helicopter to the boat," a request to confirm a new date for the opening of a shopping center, and a request for information about "4 tabletop lamps and chaise longue." At 1:39, Armstrong patched Stewart through to Bacanovic's office and hung up.

Bacanovic was in Miami, so the 27-year-old Faneuil took the call. According to the prosecution, Faneuil told Stewart about the Waksal sale attempt. (Faneuil would later say that he told her this because Bacanovic told him to; Stewart hasn't denied receiving the information, but she hasn't confirmed it, either.) While allegedly knowing about Waksal's attempted sale, a fact that the U.S. attorney and the SEC contend was "material nonpublic information," Stewart told Faneuil to sell the rest of her ImClone stock. Then, at 1:41 p.m., two minutes after being transferred to Faneuil, she hung up. Merrill Lynch completed her sell order shortly thereafter, at an average sale price of about $58.

Because the two-minute Stewart-Faneuil conversation is critical—both to assessing the propriety of the trade and to the arguments of the prosecution and defense—it needs to be considered in detail. Before we do this, however, we need to review what else was happening that morning—a subject to which I will return in my next dispatch.

Henry Blodget is the founder, editor, and CEO of Business Insider. Follow him on Twitter.